SCU Limited (SCU) sells clay tiles to the construction industry and has been in existence for the last four years. During this period, the financial controller has been refining the system of internal control and informs you that he has put together an internal control manual for the company. He has stated that this manual will create greater awareness of controls in the company, particularly with management which, in the past, has not been overly conscious of the need to implement and enforce effective internal controls.
Management staff receive bonuses based on certain agreed-upon target ratios which include measures such as targeted monthly sales volumes, variance of actual to budget departmental overheads and profit before interest and tax. The major shareholder takes an active interest in the performance of the company and is quick to request explanations on variances from the agreed-upon monthly budgets.
Two years ago, the company devoted significant time and resources to the development and implementation of a new IT system. All teething problems associated with the implementation phase have now been resolved and the financial controller is satisfied that the automated controls in place are assisting in producing accurate and complete accounting records. The sales director also looks after the IT function as the position is not regarded by management to be a full-time job. Once application programs have been tested, strict password control exists over access to the programs. Passwords are not required for access to databases.
The following information has been extracted from a review of the systems notes in the permanent file and perusal of the new internal control manual:
A) Manual delivery notes for despatch of tiles to customers are raised by the despatch department from the sales order form. Where a delivery is only partially filled, the delivery note is marked ‘hold for invoice’ and placed on the incomplete deliveries file. At month end, the supervisor of the despatch department is responsible for follow-up of the reasons for incomplete deliveries outstanding for greater than 30 days.
B) Returns of tiles by customers due to breakages, inferior quality, incorrect specifications or oversupply are received by the despatch department where staff are required to check quantity and condition of the returned tiles. Details noted by the despatch personnel, including the reason for the return, are recorded on a goods returned note. Once completed, this document is passed on to the trade receivables clerk who raises a credit note and sends it to the customer.
C) Once a delivery has occurred, the office copy manual delivery note is forwarded to the trade receivables clerk who is responsible for generating an invoice on the computer system. An invoice is raised by inputting the total quantity delivered (note: this could be a number of partial deliveries) and the stock code which are both recorded on the delivery note. The computer then automatically retrieves the stock code price from the selling price master file. Posting to the debtors account occurs automatically once the trade receivables clerk has performed a screen check on the accuracy of the input of delivery details.
D) For valued customers, discounts are applied in accordance with the company’s volume rating system. The trade receivables clerk is responsible for updating the individual customer volume ratings every six months after preparing the ‘sales volume analysis by customer’ report. This report is authorised by the sales director prior to updating the customer discounts.
E) A sales journal summarising all sales invoices is prepared monthly by the computer system. This journal is then used by the trade receivables clerk for posting to the general ledger.
F) Receipts from debtors are passed on to the trade receivables clerk after having been opened by the mail room. The trade receivables clerk lists all receipts from the debtors and then prepares a bank deposit slip. The list prepared by the trade receivables clerk is used to enter the debtors’ payments on the computer system. The batch total of postings to the individual debtors’ accounts is balanced to the bank deposit slip before processing occurs on the system.
G) At each month end, the trade receivables clerk prepares a reconciliation of the trade receivables ledger to the debtors control account in the general ledger.
H) The computer generates an aged analysis at month end based upon all invoices that have been processed onto the system for the period up until the last day of the month.
I) The financial controller obtains the latest trade receivables aged analysis at the end of each month and reviews all amounts outstanding for longer than 90 days. The trade receivables clerk is required to detail reasons for delays in payment by long outstanding debtors and the financial controller discusses items of concern with the clerk.
J) Usually an action plan is agreed for follow-up; this may include involvement of debt collectors or the issuing of writs. Where necessary, the financial controller records details of amounts that should be provided for as doubtful debtors. While performing this review, the financial controller notes the level of individual debtors’ balances and, in instances where he is uncomfortable with the level of this balance, he instructs the despatch area to withhold any shipments until a minimum prescribed payment is received.
Basically, this research paper is based on a case study of SCU Limited that related to internal control environment. In addition to this, in this research study, the concepts related to the control environment, auditing, accounting, financial would be discussed in order to fulfill the aims and objectives of the study. Moreover, this research study would also focus on the different issues. For case, in this research paper, different factors would be discusses that should be used in the assessment of the effectiveness of SCU’s control environment. In addition to this, five effective internal controls in the system of the company would be identify and described to reach the desired outcomes. On the other hand, the major weaknesses in the company’s internal control for sales and trade receivables would be addressed and discuss. Moreover, specific suggestions and strategies would be proposed in order to avoid identified weaknesses in internal control for sales and trade receivables.
Factors at SCU to Consider Assessment of Effectiveness of SCU’s Control Environment
In the present time of globalization, competitive business era and challenging business situation, it is becoming essential, valuable and significant for the companies or business firms to access their control environment in order to avoid future business challenges, reduce organizational costs, improve current control environment and attain competitive advantage. In the same way, accessing of control environment is provides various long term benefits to a company (Francis, J2004). For example, it allows the management to improve organizational productivity and business reputation at the global level. Moreover, it is also important to know that; control environment is plays a lot of significant and fundamental role in the total success and growth of an organization (Eichenwald, 2005).
Control environment can be defined as the internal environment or situation of a company that considers and present corporate culture of a company, the management style of the organization etc. For instance, control environment is also expresses a company’s organizational structure, culture, policies, strategies, values, norms, philosophy and HR policies and method in an effective and proper manner. Control environment is accessed and analyzed by the auditors of a company to conduct financial audit, internal audit and risk management methods. In the same way, accessing the control environment could improve financial position of a company. Moreover, by accessing control environment, an auditor could be able to overcome any financial and non financial risk from the company that may affect the success and performance of the company negatively. Along with this, it should also be noted down that, there are various factors that would need to consider the management or auditor in order to access and analyze effectiveness of SCU’s control environment (Pickett, 2010). The main factors are listed and discussed as below:
Organizational Structure: It is one of the major factors that should be considered by the auditor of SCU in order to analyze the effectiveness of company control environment. With the help of this, the auditor would be able to understand that how the company conducting and perfuming its business functions and operations. In addition to this, the working styles of the people of the organization would also help the auditor to access the strong of company. Moreover, through accessing the organizational structure, the auditor of SCU could be able to analyze the value, norms, standards, policies and business method. For example, he or she would access that the developed policies and methods are working as per the organizational core goals and objectives (Pour, 2006). If not, he would be responsible to link the policies with the strategic vision and mission of the company. Moreover, the nature of business activities would also be analyzed to access the effectiveness of control environment. For instance, it is important for an auditor to develop a positive and direct correlation among the level of inherent risk and size and complexity within the company’s business operations and functions. In the same way, the auditor must access the level of risk of material misstatement in the overall organizational structure of the company in form of responsibility, duties, authority, and lines of reporting meet the expected objectives (Fearnley, Beattie, and Hines, 2011).
Policies, Methods, Practices Related to Human Resource: It is also more significant for an auditor to analyze the current human resource management related practices, methods and policies in order to access the effectiveness of SCU’s control environment. It is because accessing of HRM related practices of SCU would help the auditor to understand the significant matter related to the control consciousness. For example, the auditor would analyze that the current policies are sound and better or not. If not, he will suggest the specific methods to make them more innovative and appropriate. Hence, this would help the auditor in reducing the risk associate with the material misstatement (Puncel, 2007).
Assignment of Authority and Responsibility: As per this factor, the auditor would analyze the scale of operations and size of workforce of the SCU. Additionally, the auditor would also need to consider to the authority and responsibility of assignment. Moreover, the auditor would be responsible not only to ensuring that both responsibilities and authorities are designed effectively and appropriately but also he/she would need to understand the number of experienced, talented and qualified individuals. For example, the auditor would require ensure that authorization hierarchies as well as reporting relationships are in the place or not. Furthermore, the auditor would also access that how the company properly and effectively resourced the individuals in the company to attain the goals. Moreover, he would also require analyzing the actions and practices of employees. For case, it would allow auditor that of how the employee’s actions interrelate with the actions of others and contribute to the objectives of the company (Fearnley, Beattie, and Brandt, 2005).
Philosophy and Operating Style: In the context of this factor, the auditor would evaluate the attitude, actions and practices of employees and management regarding the financial reporting. Moreover, it is also important to know that, a business firm may face different types of business risks if the philosophy and operating style is not effective and appropriate. For case, this may develop inherent risk in the company and there would be negative impact on the success of the firm. Hence, a business could encounter financial and operational risks due to poor philosophy and operating style. In the same way, it is responsibility of the auditor to analyze business risks for the company. Overall, by accessing the financial and operational inherent risks, the auditor could be able to access analyze the control environment of SCU (Rezaee, and Riley, 2009).
Communication, Commitment, and Enforcement of Integrity and Ethical Values: These are the most valuable and comprehensive tools or factors that could be used by the auditor of SCU. For example, the auditor would need know and understand that the company is promoting honesty and integrity among the employees on the day to day basis by developing and creating ethical and legal policies and standards. Moreover, it would also be analyzed that how the employees are communicating with their customers and others. Moreover, how the management of the company is dealing with employees and low level managers on a day to day basis. On the other hand, he or she would also access and analyze the ethical standards and procedures adopted by the company in conducting of various financial, and non financial transactions and practices (Rittenberg, Lohnstone, and Gramling, 2009).
Effective Internal Controls in System
The major five effective internal controls in the system of SCU are operating environment, risk assessment, control activities, information/communication and monitoring. The discussion on these effective internal controls is given below:
Operating Environment: It is also known as control environment that is organizational atmosphere by which employees, management and other organizational people conduct their functions, roles, duties and carry out their own control liabilities. Moreover, this atmosphere is play a key role in providing direction to the employees so that they could be able to understand their organizational roles, functions and tasks. Additionally, it also indicates that, the people of the company are fully knowledgeable, dedicated and committed to fulfill their objectives and goals by considering ethical principles and conducts. They are fully liable to perform various functions as per the policies and standards of the company (Gray and Manson, 2007).
Risk Assessment: It is all about reconditioning company’s business operations as well as process where internal control is essential, valuable and significant. In this control system, various kinds of risks are acceded and analyzed to attain the overall objectives. Sometime this system states that what can go wrong. Hence, in order to complete a risk assessment plan, the company would need to investigate the business cycle in the detail (Russell, 2005).
Information and Communication: It is also play a key and fundamental role in the internal control system of the company. These are the most valuable and significant elements of internal control system that plays significant role and functions in the process of collecting as well as disseminating important and valuable information throughout the company. Moreover, it is also important to know that, both communication and information is considers business system that collect specific and reliable information in the context of internal control and management. This information is used by the company and its management to support their employees so that they could be able to attain their key goals effectively (Salehi, 2009).
Monitoring: It can be defined as the current feedback tool that ensures that the company’s internal control system are designed, created and developed in an effective and more innovative manner. Moreover, there are several principles and methods are used for the effective monitoring including ongoing testing of existing control activities and process to follow when business processes change. Moreover, it is also require a specific process of communication for the effective internal control (Jackson, Moldrich, and Roebuck, 2008).
Control Activities: These are the specific and most reliable activities that conducted by the company in order to ensure that the internal control system is effective and appropriate. These control activities are created by the company in order to analyze and address and solve the risk of the organization effectively. The results of control activities are communicate to management to employees in order to attain the objectives of internal control system. In the same way, these play major role in the overall success and growth of the company (The Institute of Charted Accountants in England and Wales. 2003).
Weaknesses in Internal Control for Sales and Trade Receivables at SCU
The key purpose and aim of Sales and trade receivables system is to ensure that, the orders of the customers are executed promptly and effectively, goods/services are invoiced, bad debts are minimized, sales transactions are recorded properly in the books of account, sale invoice is developed as per rules of the company, price is correct on the sale invoice etc. Hence, if these transactions are not properly and effectively conducted, there would be weaknesses in the internal control environment of a company. In addition to this, on the basis of given case scenario, it can be said that, there are several weaknesses exits in the internal control for sales and trade receivable (Gul, 2007).
Use of Manual Delivery Notes for the Sales Transactions: It is one of the major weaknesses in the internal control system of the company related to sales and trade receivable. For example, it is fund that, SCU does not have any specific technology to conduct report and perform the sales transaction of the goods and service. The company is manual system to record and report the transaction that is creating inherits risk for the company. For example, in case of loss of manual delivery notes, the management of the company would not able to understand different aspects of sales. So, the company should adopt a computerized system in order to prepare delivery notes for the overall sales transactions (Jennings, Pany, and Reckers, 2006).
Trade receivable aged analysis is not received by the financial manger in the short time: the case clearly indicates that, the financial manager of the company is not getting the receivables aged analysis in a short period of time. It takes more than 90 days that may bring several inherent risks for the company. For example, there may be chances of fraud, mismanagement, and inappropriate use of assets. It means anyone can change the receivable transaction quickly that may affect the success of the company. But, in order to overcome this issue, the trade receivables clerk should provide report about the trade receivables aged analysis in every 15 days to bring accuracy, flexibility, accountability and creditability in the trade receivables transactions (Xinting, and Tomasic, 2010).
Lack of Accounting & Financial professional/Expert: It is accessed that, the company does not have any expert of professional to conduct the transactions related to trade. For example, in the company, the clerk is only the person that is responsible to check and prepare reconciliation of the trade receivables ledger. In this situation, the company may face several risk and challenges because the chance of fraud and misstatement may occur in the company. So, it is suggested to the company to hire professional to conduct the accounting transaction smoothly and accurately (Millichamp, 2002).
Centralized System: The Company does not have any centralized system to transfer and share the important information related to billing, invoicing and accounting. For example, the system used by the company is only generating aged analysis at month and this has been processed into the other system. This indicates that the company does not follow the principal of centralization that may create several challenges for the company. Moreover, in preparing aged analysis, the company and its employees have to spend more time and effort so it is costly for the company. Hence, the company should adopt a centralized system to share the information and data from one to another system (Lowry, 2012).
Sales People and Clerk are accountable for acting all Aspects of Credit Control: It is another weakness in the internal control system of the company that the sales people as well as clerks are responsible to perform the functions related to the credit control. For example, this risk would create the issues related to bad debts. It is because Sales People and Clerk would only be responsible to maximize the interest of customers not minimize the bad debts. Moreover, it order to deal with this issue, SCU should hire a credit controller to manage the problems effectively (Parkin, and Bullock, 2005).
Sale invoice is sent to the customer on receipts of a return customer order: Due to the defect in the product, the customer sent back product to the company and company does not receive the original bill from the customers that is a major issue in the internal control of the company. Moreover, there may be several implications due to this. For case, the sale revenue of the company can be recognized incorrectly and inappropriately (Schmidt, 2012).
Sales bonuses/ Discounts are applied on the basis of Company’s Volume Rating system: As per the company policy, big discounts are given to the valued customers by using volume rating system. This may create risks and challenges for the company in making discounts in respect to the non-completed sales transactions that negatively affect the profitability of the company and results in low market share. So, it is suggested to the company that it should adopt more specific and appropriate method as compare to volume rating system (Tepalagul, and Lin, 2015).
Inadequate controls over the opening of customer accounts in the trade receivables ledger: This may affect the success of the company in the market due to increased risk of losses as a result of bad debts arising on sales to un-creditworthy clientele and a danger of defeat as a result of deliveries to fictitious clients. But, such issues can be handled and managed by the company by adopting rigorous control procedures at the workplace. For example, they must also focus on checking all the transactions (Moeller, 2009).
The truncations and records related to the billing and invoicing are recorded in SCU’s financial statements without prior approval from a responsible bureaucrat of the corporation: This is the last and most important weakness in the internal control environment of the company that could have negative impact on the total success of the company. For example, the unauthentic and unofficial accounting transactions can be entered into the SCU’s accounting and financial records. It can affect the level of financial information at the company and create disputes and conflict with customer. So, it would be total loss of goodwill (Umar and Anandarajan, 2004).
On the basis of above discussion, it can be concluded that, control environment of a company reflects core values, norms, strategies, policies and business methods. Moreover, it is also analyzed that, in order to access the effectiveness of control environment, an auditor must consider various factors. Moreover, it can also be concluded that, several kinds of effective internal controls in the system could be used effectively. Finally, it can be concluded that, business organizations should adopt proper methods, techniques, strategies and ways in order to avoid weaknesses in their internal control systems.
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